Lance Hood:               Richard I think everyone worries about the seller cooking the books. So how can someone make sure that they aren't caught in that situation.

Richard Parker:           Well here's the greatest thing. Numbers don't lie, people do and I know that's simplistic, that's paramount to everything related to numbers. They don't lie. Here's what they are, they're either provable or they're not provable. End of story.

                                    So when you look at the numbers there's no disputing them. If there's no mechanism for them to prove the numbers they just don't exists. It's either a lie or they're inaccurate or incorrect.

                                    So keep that in mind. Numbers don't lie, people do. Sellers do try to cook the books. It does happen from time-to-time. Less so than it used to but it does happen but again, if you have the numbers they're very easy to validate.

                                    The second thing is never ever, ever take the seller's word for something. Everything needs to be validated. You want to ask them the right questions. You want to note their answers. You want to use it for your research but you're not taking that as gospel. You've got to validate everything that they say.

                                    And the third thing is you want to hire a good accountant. No matter how comfortable you are with numbers nothing beats a second set of experienced eyeballs looking at financial statements.

                                    So you can go through the initial stages of reviewing them yourself, looking for the inconsistencies or the disturbances in the numbers. Drawing - using tools to help you with the valuation. But when the time comes to validate those numbers in the stage that we call due diligence of any business, you certainly want to engage a competent and experienced accountant to be that second set of eyeballs and to really validate the numbers for you to make sure all the checks and balances and the paper trail exists for everything that's been represented.

                                    But again, I underline all of this with the fact that numbers don't lie. They are what they are.

Lance Hood:               What are some of the ways that sellers can manipulate the financials to make them look better than they are?

Richard Parker:           There are actually a number of ways. Increasing or decreasing certain expenses like marketing, you're Yellow Page ads that make the bottom-line look better. And that's again why you look for inconsistencies. You have situations in a smaller business where family members are doing work at the company for less than market rates. You walk into the restaurant and the guy who's the owner is behind the counter. And you're talking to him about the employees and you said, "Who's that lady over there?" He says, "That's my wife." "What does she do?" "She's the Hostess." "Well how much do you pay her?" "Pay her? She works for my house." "Well who's that young lady over there behind the counter?" "That's my daughter." "How much do you pay her?" "Pay her? She lives in my house." Right?

                                    Well you buy a business you've got to replace all those people and pay them. Or very often you have a case of a husband and wife team - the wife owns the business and you see that the husband works there. She says, "Oh he only comes in few hours a week to do the books." Right? Well you find out that you're going to need a bookkeeper who will work 14 hours a week or 20 hours a week and she doesn't pay her husband. Well you're going to have to pay someone to do it.

                                    So again, family members doing work at the company either for zero or for less than market rates that you're going to need to employ.

                                    You have situations where the seller owns the building and may charge the company less rent than the new owner will have to pay if they don't buy the building from them.

                                    You have situations where an owner may own multiple businesses where some of the expenses are intermingled. And I lived through that exactly.

                                    You have situations where a seller may have convinced certain customers to increase their purchases temporarily to pretty up the books. Or you have situations where you talked about it earlier, about cash business. You have sellers paying some the employees cash. It's very dangerous. So they're collecting cash, they're paying them cash. They don't show as expenses to the business. Suddenly you come in and you don't have the cash or you don't know where to get it and these people are saying, "Well so-and-so used to pay me in cash." "Well how do I know that?" "Well I work here." "Yeah but here's your salary on the books." "Well I got X amount of cash over and above that."

                                    And so you suddenly have more expenses but also the seller has demonstrated that he's having someone who's doing the work for the business but the cost of that employee does not show on the books and record. So that's another way they could easily pretty up the numbers. And it doesn't happen all the time but these are all things that you need to look for.

                                    Pretty commonsense once you know what you're doing.

Lance Hood:               Richard, I'd like to spend sometime talking about how people can grasp basic accounting quickly and effectively. Can you tell me how to properly interpret financial statements in one hour?

Richard Parker:           Well, tall order but you really need two things. You need financial statements and a pencil. Financial statements generally follow a set pattern. So first before we sort of elaborate upon that let me allude to the point that a lot of people are intimidated by financial statements and there's no need for that to happen. You don't need to be a math whiz. You simply need to understand the mechanics and the intention of the report. And it's really about four things; revenue, expenses, assets, and liabilities. That's it. Revenue; sales of the business. Expenses; cost they incur. To what are the assets of the business? Those could be from equipment to receivables. And what are the liabilities? What does the business owe?

                                    So you take those four things, pretty simple, and then all you need to do is know to add, subtract, multiply, and divide. And I promise you it's not more difficult than that.

                                    Now the simplest way - when you're looking at financial statements is to look for consistencies or inconsistencies when comparing different periods. You know, one year over another. One month compared to another. Two years ago compared to this year. Line items of sales and expenses, and the various expenses that a business incurs or different ways that the business generates it's sales. And you're comparing it year-to-year, or looking for inconsistencies. Okay? And again, you don't need to be an expert. Got it?

                                    Let me take you back a little bit to talk about these inconsistencies and a good example, I think I talked about it earlier how I love to fly fish. I used to slap the water. I love salmon fishing. Atlantic salmon fishing in Canada it's an incredible experience. But I when I used to go on these trips and I loved them and I had a great time. The camaraderie is unbelievable but I couldn't catch any fish. I mean fly fishing was difficult enough and salmon don't feed in fresh water. They don't even know why they go after certain flies, but they do. And so catching a salmon is like it's not impossible, it certainly is for me in some cases, but it's a very, very difficult game fish.

                                    I remember speaking with a friend of mine. He's a very accomplished fly fisherman in Newfoundland, Canada and saying, "I can't even see the fish." Because the idea is you're fly is out there and the fish comes up to the top of dark water and very often crunch on you're fly and spit it out. I mean that's what they do because they don't feed. I said, "I don't have the greatest vision. How do you even see that?" If you're looking to look at a point in dark water 40 feet down or 60 feet down how do you even discriminate? How do you even see the fish that comes up in a nano-second?

                                    He gave me a great example. He said, "All you want to do is look for a disturbance in the water. You throw out your fly and your fly is going in the water. Imagine if you will that you're just looking for a disturbance in the water. Well looking for a disturbance in the water is much easier than trying to keep your eye on a tiny fly that's the size of a pinky nail that's 60 feet down and you're not exactly sure where it is. Look for a disturbance of the water.

                                    And I took that attitude in mind and the next day hooked three salmon.

Lance Hood:               Wow!  

Richard Parker:           And I've been reasonably good since then because I just look for a disturbance in the water. I can't possibly see the fish's lips coming out of dark water to crush a tiny fly sixty feet downstream, but I can notice activity in the water that disrupts the pattern...it's a disturbance. It's the same way in a financial statement's you're looking for consistencies or inconsistencies. You're looking at these statements and asking: What doesn't make sense? What doesn't follow a pattern? What numbers are out-of-line from prior years?

Well it doesn't make sense if last year the cost of their goods was 42% of the sales they generated, and this year it's 68%. Something's wrong. Why did they spend $4000 on marketing, and the year before they spent $24,000 on marketing. Why last year did they have maintenance of their vehicles of $62,000, and this year it's $12? Well maybe they're positioning the business to sell and trying to lower their expenses so that it shows more profits so they can sell it for more money. There's some inconsistencies right there.

                                    So you're looking for disturbances in the numbers. Doesn't that Imake sense?

Lance Hood:               That makes a lot of sense.

Richard Parker:           And again, you don't have to be an expert. You're going to engage an accountant to validate or disprove everything, but you absolutely must become familiar with numbers in financial statements or you're not going to be able to buy a business. Because you want to be able to look and have a good general overview of the numbers when you first get them as opposed to paying an accountant X hundreds of dollars an hour every time you see a business of interest. You want to be able to look at the statements first yourself, and just get a general overview.

                                    Again, you don't have to be an expert. You don't have to draw these intimate valuations related to it. Our software does all that for you, but you want to be able to have a level of familiarity and comfort with them.

                                    More important than understanding them at the beginning of searching for a business, is when you operate a business you want to have the basic accounting skills and able to run it successfully. But don't panic. An example I like to use is Michael Eisner who is the longtime and hugely success Chief Executive Officer of Disney. I mean he admitted in his book when he became the CEO originally of Disney he had no clue whatsoever how to even read a balance sheet so I guess there's really hope for all of us.